Wednesday, November 14, 2007

Against the Gold Standard

Jerry Bowyer at Townhall makes the case against the gold standard, which historically has been used to back national currencies. The problem is that gold is not a reliable indicator of economic growth. Bowyer correctly points out that the price of gold has skyrocketed, but that it is not necessarily an indicator of future inflation and/or economic growth. Here's the historically good part of the Gold Standard.

"Over long periods of time human production of gold had increased at roughly the same pace as human production of everything else. At times when the worldwide economy was growing at about 1%, the worldwide growth of gold reserves was also running at about 1%. This meant that a currency backed by gold would grow and shrink at roughly the same rate as the economy in general. This fact is the basis of what economists call the “Gold Standard”. If the money supply grew at the same pace as the supply of goods and services, then the prices would remain stable."

The issue now is that we've decoupled gold from our currency and instituted a free floating currency, which rises and falls against other currencies in foreign exchange markets. Some politicians (notable Ron Paul) have proposed returning to the Gold Standard. Thus would be an enormous mistake, as there are considerable issues with tying the value of gold to either national currency or the rate of economic growth - sometimes they don't correlate, as in times of major gold discoveries and in times of high economic innovation.

"For example, after Christopher Columbus discovered the New World, European conquerors swept through Central America and plundered its gold. The yellow metal flowed back across the Atlantic by the boatload for the entire 16th Century. The explorers had found an extremely efficient way of producing gold—by stealing it. However, the economy of Europe had not been as successful at finding highly efficient ways of producing any other goods and services. Not surprisingly, prices exploded upward, destabilizing both Europe’s prices, and its political systems.

The opposite occurred in the 19th Century. For example, the 1830s were characterized by enormous explosions in wealth generation in the English-speaking world due to the commercial application of railroads. But gold supplies did not expand at the same pace. Goods increased, gold didn’t, and price deflation was the result. In fact, it wasn’t until 1849 and the discovery of gold in California by the now-famous 49ers that this long drought of deflation ended. I could multiply examples, and so could you if you simply went to Google and typed in the words ‘panic of’. You will learn about the panic of 1837, the panic of 1893, and 1907. And of course we all know about the panic of 1929."

Bowyers point is that we are in such an innovative and explosive economic growth phase right now globally, as nations such as China, India, and Eastern Europe (as well as many others) adopt free market economic reforms, adopt new tax regimes, and develop knowledge based industries such as computer programming. The fastest growing secotr of the global economy is based on sand and electrons, which have nothing to do with the price of gold - therefore either basing our currency on gold and/or looking at gold as a future price level indicator is not valid.

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